MSCI ESG METRICS - A BIG DATA APPROACH TO ESG

MSCI ESG Metrics is designed to deliver a broad set of standardized ESG data and simple metrics that are comparable across a broad universe of 8,500 companies (the MSCI ACWI Investable Market Index (IMI)). Developed initially as inputs into the MSCI ESG Ratings model, these newly available datasets can be used by institutional investors as inputs for in-house analytical models or to develop proprietary investment strategies. The tool, which is based on 40 years of experience collecting, standardizing and modeling ESG metrics, introduces:

Risk Exposure

Management Practices

Performance

Controversies

New “risk exposure” dataset, mapping over 50,000 individual business and geographic segments to 22 macro risk factors, such as carbon regulation, water stressed regions, and corruption risks.

The practices data set offers insight into a company’s capabilities to manage ESG risks or capitalizing market ESG opportunity such as policy commitments, certifications, risk mitigation initiatives and programs, and targets to improve performance

The performance data set evaluates the company’s historical track record on managing the specific ESG risk . Performance data involves collecting, standardizing, and benchmarking a range of quantitative indicators where applicable

The controversies data set offers insights into a company’s involvement in notable ESG controversies (e.g. lawsuits, disputes, regulatory actions) related to the company’s operations and/or products, possible breaches of international norms and principles

MSCI ESG METRICS – GEOGRAPHIC ESG RISK EXPOSURE MAP

Geographic exposure to...

In December 2015, close to 200 governments committed to undertake coordinated policy measures designed to limit the global temperature rise to two degrees Celsius.1 Regulatory mechanisms including carbon pricing and quotas, and policies to incentivize climate finance and renewable energy,2are imposing both direct and indirect costs for high-emitting industries.

This map indicates where MSCI ESG Research considers carbon regulatory risks to be the highest, based on our analysis of three factors: 1) each country’s annual emissions reduction implied by its stated targets, 2) contingency of country targets on external support, and 3) the required emissions reduction implied by the country’s share of the remaining global carbon budget.

Country in focus: Canada

Canada’s greenhouse gas (GHG) emissions (almost 28.8 tons per capita per year) are well above the global median (5.7 tons per capita) and represent over 1.5% of the world’s total GHG emissions.3 The development of oil sands has contributed to the country's high emissions. Canada withdrew from the Kyoto Protocol in 2011 and is set to miss its 2020 GHG emissions reduction target of 17% by 2020 at 2005 levels.4

However, since the Liberal Party came into power in October 2015, climate change is back on the country’s agenda. The country has committed to a 30% emission reduction below 2005 levels by 2030 and a new climate finance commitment of around CAD 2.65 billion over the 2015-2020 period. Canada has planned a number of carbon emission reduction initiatives that include carbon pricing, investments in clean energy technology, infrastructure, and innovation.5

Climate change and rising demand for freshwater are exerting greater pressure on existing water supplies. In many regions such as the Mediterranean and southern Africa, rising temperatures, changing rainfall patterns and polluted water supplies could dramatically shrink the available water supply.1 Extreme weather events like extended droughts and heat waves are occurring with greater frequency and severity, especially in parts of the US, China, Chile, Spain, Italy and Portugal.

Even as supplies of freshwater shrink, global demand for freshwater continues to grow. Pressure on water resources will likely continue to rise, fueled by global population growth, greater affluence, changes in lifestyles and eating habits, and a trend toward shifting water use from agriculture to higher value urban and industrial uses.2

Country in focus: Chile

While Chile has a high availability of water resources at the national level (almost 50,000 cubic meters per capita) and low water withdrawal levels (4% of available renewable water resources),3 the northern and central regions, which constitute more than 70% of the total population, are severely water stressed. Further, the country has witnessed glacier retreat, which could have significant impact on water supply as glaciers act as strategic water reserves,4 while mudslides and floods in early 2017 have contaminated drinking water resources curtailing water availability for use in capital region of Santiago.5

Water stress has already created costs for companies with fixed assets in Chile. For instance, in 2013, operators of the Escondida copper mine in the Atacama Desert, often considered the driest place on earth, approved to invest USD 3.4 billion in water supply facility to desalinate and pump in seawater in order to support their operations.6

Certain regions are more vulnerable to environmental degradation from industrial activity. Companies that operate in geographies with fragile and unique ecosystems and stressed natural resources (e.g. high levels of deforestation) may face additional hurdles when acquiring or maintaining their social license to operate.

Environmental controversies in highly vulnerable regions have historically resulted in litigation, stringent regulatory action, reputational damage, or high costs associated with mitigating damage (for example, costly tailings remediation). Perceived threats to agriculture, water supplies, or cultural areas can lead to protracted conflicts with local communities, which in turn may cause operational disruptions, lost cash flows, and even assets write-downs if a company’s operating permit is revoked.

COUNTRY IN FOCUS: INDONESIA

Vast areas of forestlands in Indonesia have been razed to meet the growing global demand for palm oil. Rapid industrialization has also caused a decrease in the forest cover available for several plant and animal species to survive: 14% of all species indigenous to Indonesia are considered endangered.1

In 2011, the government initiated a moratorium on any new palm oil permits in natural primary forest, and extended the moratorium in May 2015 for another two years. However, Indonesia exempts secondary forest and existing concessions and makes exemptions for national development projects – geothermal, oil and gas, electricity, rice, sugarcane.2

There is consensus that climate change will lead to more frequent and unpredictable weather events as greenhouse gas emissions continue to rise.1 Typhoons and hurricanes will likely involve heavier precipitation and higher peak wind speeds, driven by increases in tropical sea-surface temperatures, while evidence of rising sea levels and storm surges are of particular concern to low-lying regions.

This is a reality the insurance sector has known for years.2 Large swaths of homeowners in the US, for example, moved to government-subsidized insurance because private insurers would no longer bear the risks of an increase in the intensity of storms or the rise of sea levels.3 Companies with fixed assets and insured exposures in climate vulnerable regions may face increasing business continuity risks, rising insurance costs, and declining asset values, particularly if global policy efforts fail to limit warming to under two degrees Celsius.

Although the exact pace of climate change impacts are uncertain, economic costs may be felt sooner, as climate-related risks may be priced into insurance premiums, raise borrowing costs, or render certain long-lived assets uninsurable.4

Country in focus: United States of America

Contrary to public opinion,5 the United States is actually among the most vulnerable countries to the physical effects of climate change, based on research compiled by MSCI ESG Research. Risks range from exacerbating water stress in the West and Southwest, to increasing storm strength and inland flooding on the Eastern seaboard where many of the largest cities are located.

A series of natural disasters in recent years underscore the potential threat and high cost of such events – in 2016 alone, the US experienced 15 weather and climate disaster events where losses exceeded USD 1 billion.6

Technological developments are bringing sweeping changes to labor markets globally, causing upheavals felt by high- and low-skilled workers alike. MSCI ESG Research analysis estimates that income inequality has increased in 63% of countries from 1980 to the current decade 1 and economic disruptions have led some companies to lay off workers or restructure their businesses. Companies that rely on large and complex workforces in areas facing higher levels of labor unrest and work stoppages (strikes, lockouts) may face heightened operational risk and weakened labor relations because of these exogenous pressures.

Poor labor relations may lead to job dissatisfaction, increased labor costs, and reduced productivity over the long term, while industrial action such as strikes in response to workforce restructuring and labor conditions can lead to more immediate production and extended service disruptions.

COUNTRY IN FOCUS: SOUTH AFRICA

South Africa has witnessed frequent protests over a number of issues ranging from service delivery to working conditions, in some cases leading to violent restraint. South Africa’s overall unemployment rate remained high at almost 26% (total labor force) and youth unemployment reached almost 52% (labor force between 15-24 years).2 It has one of the highest income inequality gaps globally,3 which is increasing year-on-year. If these conditions persist and political infighting continues to hamper economic growth,4 strikes may become an even greater operational risk issue for companies operating in South Africa.

1 MSCI ESG Research analysis of GINI coefficients sourced from the World Bank and US CIA World Factbook, as of April 2016.

As companies expand their footprint globally, they may expose themselves to greater regional discrepancies in workplace safety standards. Operational risks may be more pronounced in countries with less regulatory oversight and weaker enforcement, placing a greater burden on companies to set and achieve above-market standards. Occupational health and safety controversies can lead to production disruptions, litigation, and liabilities tied to compensation, along with reduced morale, reputational damage.

COUNTRY IN FOCUS: CHINA

China has seen a series of industrial accidents leading to 66,000 workplace deaths and around 282,000 workplace accidents in 2015 according to the National People’s Congress (NPC) of China.1 With around 6.0 occupational fatalities per USD billion Gross Domestic Product (GDP), the workplace fatality rate in China is more than twenty times that of other major global economies (United States 0.27, Japan 0.22, Germany 0.19, and United Kingdom 0.05).2 The large disparity can be attributed to a lax regulatory environment and uneven enforcement surrounding workplace safety.3

Emerging chemical safety regulations and shifting demand dynamics have the potential to raise costs and erode market share for companies that produce hazardous substances. These regulatory trends may pressure companies to improve transparency and develop products with low environmental and health impacts. While chemical regulation has been strengthening on a continuous basis in Europe,1 new regulations in Asia 2 and legislative reforms to existing regulations 3 are widening the geographic net of applicable chemical regulations.

As regulatory bodies progressively identify new substances of very high concern, more companies are being held responsible for evaluating the chemical safety of their products and supply chains. Where economically feasible alternatives exist or where the risk is deemed too high, it is possible that substances of very high concern (SVHCs) could be taken off the market in these high-risk regions. This might lead to companies losing product applications in certain end-markets or requiring process adjustments to mitigate the strengthening regulations.

Region in focus: Asia Pacific

The East Asia region represents one of the most promising chemical markets in the world, with almost half the 2016 global chemical sales coming from the region.4 Yet in recent years, countries in the region have widened their regulatory net to include more checks on the use of hazardous chemicals. China (MEP Order 7), South Korea (Act on the Registration and Evaluation of Chemicals), and Taiwan (Toxic Chemical Substance Control Act) have recently adopted REACH-like regulations to improve oversight of chemical hazards. These regulations expose companies reliant on substances of very high concern to potential lost revenues and potential future costs arising from reformulation or process adjustments.

Global regulatory momentum in response to growing privacy concerns and cyber-attacks is mounting. In 2014, cybercrime alone cost the global economy an estimated USD 445 billion.1 Companies that collect and monetize user data without their explicit consent flirt with violations of consumers’ right to privacy.2 Data breaches are on the rise in both frequency and sophistication with the average cost of data breaches increasing every year (from USD 130 average cost per lost or stolen record to 158 in 2016).3 In the case of any controversial involvement in using or handling customer data, companies may be vulnerable to costly reputational damage, loss of customers, litigation, and possible regulatory action.

Risks to companies are mounting in major markets where we see regulatory momentum to address privacy concerns and cyber-attacks. We are witnessing the strengthening of existing privacy and data security regulations (e.g. EU, US, Singapore, and South Korea), as well as the creation of new laws where data protection regulations did not yet exist, notably in Asia,4 the Middle East,5 and South America.6

Region in focus: European Union

In the EU, the General Data Protection Regulation (GDPR) has been passed after three years of discussion and will likely be implemented in the first half of 2018.7 The GDPR provides a “one stop shop” regulation that will be applied across EU member states and outlines stringent requirements for data controllers and processors that have data on EU citizens.8

Specially, the regulation mandates data security impact assessments, a privacy by design approach, user notification and consent in case of data transfer outside the EU, the designation of a Data Protection Officer in some cases, and right to be forgotten for users.9 These requirements, expected to be enforced by 2018, may pose significant additional costs for companies, as they may need to revise compliance procedures or redesign their IT systems to comply with a much stricter privacy framework (e.g. mandatory data breach notification, data protection officers). Companies handling EU citizens’ data risk hefty financial penalties of up to 4% of annual turnover in case of violations.10

The IMF estimates that bribery costs the global economy as much as USD 1.5 trillion per year,1 yet accusations of corruption remain surprisingly prevalent among global companies. We estimate that 13% of MSCI ACWI companies have been involved in at least one corruption controversy over the last three years.2 Increased enforcement in both developed and emerging markets to abate corruption – including multi-million penalties linked crackdowns in the UK (Rolls-Royce), China (GlaxoSmithKline (GSK)), and Brazil (Odebrecht/Braskem, Alstom) - has made unethical business conduct an increasingly risky strategy for global firms.

COUNTRY IN FOCUS: ARGENTINA

Argentina is still reeling from former President Cristina Fernández de Kirchner’s involvement in number of criminal investigations over her alleged involved in over-billing public works contracts.3 While the country has consistently fared poorly on corruption perception levels, it is showing signs of improvement with a jump of 12 positions in the Corruption Perception Index by Transparency International (from 107th 2015 to 95th in 2016, out of 176 countries).4

The country has left behind a populist government and is considering new anti-corruption legislation, enforcement mechanisms, and higher penalties (up to 20% of gross income of previous year and suspension of activities up to 10 years) for companies involved in public sector corruption.5 In the meantime, scrutiny into company practices has increased – in 2016, Argentine prosecutors were investigating over 100 companies for involvement in bribery of government officials stemming from Brazil’s ‘Operation Car Wash’.6

Source: Data in interactive map derived from Corruption Perception Index (Transparency International); World Bank (Control of Corruption Indicator, Political Stability and Absence of Violence/Terrorism and Rule of Low Indicator); MSCI ESG Research

Factsheet

MSCI ESG Metrics is a tool designed to give institutional investors a broad set of standardized ESG data and simple flagged metrics that are comparable across a broad universe of 8,500 companies in the MSCI ACWI Investable Market Index (IMI) coverage universe.